Out of Options

While in the process of getting divorced three years ago, Sparkle Parks, a 38-year-old administrator at Ohio State University's medical center, found herself five months behind on her mortgage payments and burdened with $8,000 in credit-card debt. "I was used to two incomes," she says, "but when my husband stopped making the house payments, all of the responsibility fell on me.... I ended up falling behind financially."

In order to save the four-bedroom house where she and her two children had lived for seven years, Parks sought the protection of the bankruptcy courts. In 2002, she filed for Chapter 13, and is now paying back her creditors on a five-year schedule that will allow her to settle all of her debts.

Unlike many bankruptcy filers, Parks says she doesn't feel embarrassed about what happened, because it taught her a valuable lesson. "My mistake (before bankruptcy) was that I wasn't saving," she says. Now, she's budgeting carefully, placing whatever is left at the end of the month into a savings account. "(The bankruptcy) made me rethink how I deal with my money," she says. "It just made me wiser financially."

For Parks, bankruptcy worked out the way it was supposed to: It gave her a chance for a fresh financial start. But that's not the case for about half of the 1.5 million people who file each year — up from 820,000 in 1991. According to the Consumer Bankruptcy Project, a Harvard University-based research group that has studied bankruptcy over the past 15 years, about half (49.7%) of all bankruptcy filers said their financial situation had improved a year after filing. But 34.9% say it stayed the same, while 15.4% of filers say their situation had gotten worse.

Those figures are troubling, says Dr. Deborah Thorne, a sociology professor at Ohio University and one of the Project's leading researchers. "Remember that their financial situation before bankruptcy was typically awful," she says.

Steve Rhode, founder of credit-counseling organization MyVesta who currently runs his own money-coaching practice, says he has seen many of his clients file for bankruptcy only to fall into financial trouble again. The reasons? Some people aren't able to discharge their largest debts (for example, student loans), so even after bankruptcy, they struggle. For others, it's the lack of proper follow-up action. They don't realize that bankruptcy isn't the final step in resolving their problems, says Rhode. "Bankruptcy is a good tool in a big plan, but it's not the tool you can use to definitely say that you're going to be better off in the future."

Most filers, for example, swear off credit cards, not realizing that obtaining new credit is the most important thing to do after filing, says Gerri Detweiler, author of The Ultimate Credit Handbook. "This sounds scary for someone who's been to bankruptcy," she says, "but if you don't, you won't be able to move forward." A poor credit history will lead to higher interest rates and insurance premiums, and with many companies checking prospective employees' credit records, it may even cost someone a job.

Another problem: Contrary to popular opinion, most bankruptcies aren't simply the result of overspending. Only 4.3% of all consumer bankruptcies in 2001 were filed solely as a result of credit-card debt, according to the Consumer Bankruptcy Project. Job loss is one of the leading causes for bankruptcy. "We had a recession, and as far as jobs are concerned, we're still having one," says Marianne Culhane, who teaches bankruptcy at the Creighton University Law School in Omaha, Neb. And with health-care costs skyrocketing, the more than 44 million people living without health insurance are "just one accident or major disease away from financial ruin."

In addition, for many young families with children, the pressure to move into expensive neighborhoods with good schools often causes them to allocate so much of their income to mortgage payments that any change in their financial picture, like a divorce or an unexpected illness, could easily send them over the brink. Dr. Elizabeth Warren, a professor at Harvard Law School and one of the leading researchers in the Consumer Bankruptcy Project, writes in her book "The Two-Income Trap" that married couples with children are more than twice as likely to file for bankruptcy as families without children. Single mothers file three times more often than their childless counterparts.

At the same time, filing for bankruptcy isn't an easy decision. According to the Consumer Bankruptcy Project, half of all households have had their utilities or telephone shut off before they filed for bankruptcy; nearly 60% did not get medical care they needed, and at some point, one in five families had gone without food.

Rhode says he sees many people who don't want to even consider bankruptcy because they feel a moral responsibility to their past. "What they never consider is (that) they have a greater responsibility for their future," he says. The classic example: a young couple that barely pays its bills each month, doesn't have anything left to put into savings and can't afford to pay for health insurance. "If you're in a situation where you can't save and you can't afford insurance," he says, "you should probably think about utilizing bankruptcy as an option, so you can keep your family safe, at least."

So what's the key to a successful bankruptcy? Knowing that your work is just starting when you file, not ending. Parks, for example, started attending personal-finance classes at her church immediately after she filed, and trimmed down her budget as much as she could. She now drives a 1994 Saturn that's completely paid off, rents free videos from the library instead of going to the movies and has cancelled the family's cable TV. "My whole perspective is totally different," she says.